Contributing to your 401(k) is a great way to prepare for retirement, allowing for tax-deferred growth and, in some cases, employer matching contributions. If you really want to boost your savings, you might even contribute the maximum to the account. For 2020, the 401(k) annual contribution limit increased by $500, to $19,500. This is up from $19,000 in 2019. For employees over 50, there are also catch-up contributions. The limits for these also saw a $500 hike from $6,000 to $6,500. Note that the IRS also has rules surrounding 401(k) employer matching.
Consider meeting with a financial advisor for guidance on maximizing your retirement savings.
What Is the 401(k) Contribution Limit for 2020?
A 401(k) is a common type of retirement account that’s available through an employer. For the most part, these accounts are funded with pre-tax dollars. As a result, you typically won’t pay taxes on that money until you withdraw it in retirement. These accounts also come in a Roth variation, which is the opposite of the aforementioned setup. More specifically, a Roth 401(k) allows you to avoid taxes in retirement by paying for them upfront.
The IRS imposes a cap on how much you can contribute to your 401(k) on an annual basis. This is called the 401(k) contribution limit. Here are the rules for 2020, along with how they compare to 2019’s limits:
|401(k) Contribution Limits: 2020 vs. 2019|
|Type of Contribution||2020 Limit||2019 Limit|
|Standard 401(k) contributions||$19,500||$19,000|
|Catch-up contributions (over age 50)||$6,500||$6,000|
|SIMPLE 401(k) contributions||$13,500||$13,000|
As the table above illustrates, the 2020 IRS limit for employee 401(k) contributions jumped $500 from the 2019 mark to $19,500. Contribution limits tend to increase during years where inflation rates also climb. This has been the case since 2009, as the rate has either increased or stayed put each year since then.
The catch-up contributions listed in the table only apply to employees who are 50 or older. For these individuals, the IRS permits an extra $6,500 in contributions each year. That’s again up $500 from the 2019 limit of $6,000. So anyone who’s at least 50 years old and enrolled in a 401(k) can contribute as much as $26,000 to their 401(k) in 2020.
Although 401(k)s are one of the most popular retirement accounts available today, the contribution limits above also apply to other retirement plans. In fact, 403(b)s, most 457 plans and the federal Thrift Savings Plan also adopt these stipulations.
Contribution Limits for Employer Matching and Highly Compensated Employees (HCEs)
Some employers will match contributions to a 401(k) account, up to a certain point. For instance, your employer may match 50% of your contributions up to 5% of your total salary. These matching contributions don’t factor into the $19,500 standard contribution or $6,500 catch-up contribution limits, though. However, there is an overall limit for matching contributions. In 2020, that ceiling is the lesser of $57,000 or 100% of the employee’s salary.
The IRS has a specific tax status called “highly compensated employee,” or HCE. According to the IRS website, the 2020 requirements for an HCE go as follows:
- Over the previous year, the employee earned $130,000 or more OR
- The employee owns more than 5% of the interest in the business at any point during the current or preceding year, regardless of compensation
While there are no explicit differences in the way the IRS limits the 401(k) contributions of HCEs, the 401(k) plan they utilize must meet some standards. The IRS determines this by testing the plan to ensure that it does not favor HCEs in any way. Should this process uncover that the plan is, in fact, treating HCEs and non-HCEs differently, there may be limits placed on the contributions of those HCEs.
Should You Max Out Your 401(k) Contributions?
If you have the means, contributing the full amount to your 401(k) could have major benefits. Some experts, though, would urge you to think about filling other needs before you max out your 401(k). For starters, certain non-retirement needs may come first. These might include paying off high-interest debts or loans, stocking your emergency fund accounts, maintaining solid health insurance and investing in long-term care insurance if you’re over 50.
There are also other options for saving for retirement. Perhaps the most notable partner of a 401(k) is the individual retirement account (IRA). So if you want to contribute more than the 401(k) limit allows you to, consider opening an IRA too. The 2020 IRA contribution limit remains unchanged from 2019 at $6,000. The catch-up contribution limit is $1,000, which is again the same as it was in 2019.
A Roth IRA might be a particularly good destination for your extra retirement funds. Since a Roth account offers tax-free growth and distributions, it might be a good complement to your tax-deferred 401(k). Note that even if you do favor an IRA, you should still contribute enough to your 401(k) to secure any employer matching perks.
Tax and Investment Benefits of a 401(k)
The most notable benefit of a 401(k) is that all contributions are tax-deferred. Your plan is funded directly from your paycheck, with the money coming out before it’s subject to income taxes. By reducing your taxable income, you’re essentially taking a tax deduction, for now. Furthermore, because less of your paycheck is going towards taxes, you’re able to contribute more to your retirement funds.
With a 401(k), you’ll have a choice of investing in multiple types of investments. These often include some combination of mutual funds, exchange-traded funds (ETFs), index funds, bond funds and various market capitalization funds. Many 401(k) plans provide access to investments called target-date funds, which automatically rebalance your portfolio to reduce riskiness as you approach your target retirement age.
The 401(k) contribution limit for 2020 is $19,500. Workers 50 and older gain access to an additional catch-up contribution limit of $6,500, so they can contribute up to $26,000 in 2020. Be sure to take advantage of your company’s matching program as well. Note that your employer’s matching contributions don’t count toward the caps above.
Once you square away your other financial commitments, eliminate debt and have a cushion of funds for emergencies, consider getting as close as you can to the 401(k) contribution limits. Doing so will go a long way toward setting yourself up for a secure retirement.
Tips for Managing Your Retirement Savings
- Saving for retirement is much easier said than done, but a financial advisor can get you on the right track. Luckily, your search for a suitable financial advisor can be made much easier with SmartAsset’s free advisor matching tool. Simply answer a series of questions about your personal needs, and you’ll be paired with up to three advisors in your area. Get started now.
- A 401(k) isn’t the only place you should be saving for retirement. An individual retirement account, or IRA, is another option. It has a contribution limit of $6,000 for 2020. A traditional IRA offers the same tax benefits as a 401(k). Roth IRAs, on the other hand, don’t provide an upfront tax deduction, though you won’t have to pay taxes on your income when you retire.
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